Commentaries (some of them cheeky or provocative) on economic topics by Ralph Musgrave. This site is dedicated to Abba Lerner. I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics.

Friday, 28 February 2014

The UK’s IndependentCommission on Banking, the so called “Vickers Commission”,
objected to full reserve banking. Their reasons are in section 3.20, 3.21 and
3.22.

Their first mistake is to
make a distinction between what they call “narrow banking” (section 3.20) and
what they call “limited purpose banking” (3.22). They claim that narrow banking
involves not lending on depositors’ money: e.g. simply lodging such money at
the central bank or investing in government debt.

In contrast, they claim
that limited purpose banking involves having lending institutions funded just
by loss absorbers or shareholders.

Well now, if institutions
that accept deposits cannot lend on those deposits, then necessarily
institutions that lend will be funded not by depositors but by shareholders or
similar types of loss absorber! Thus “limited purpose” and “narrow” banking are
simply opposite sides of the same coin. Indeed, that fact was explicitly
recognised by Milton Friedman
and Lawrence Kotlikoff in that the banking systems the advocate involve
splitting the banking industry into two halves: entities or accounts which
simply accept deposits and warehouse money, and second, entities which lend,
but which are funded by shareholders.

Thus in the paragraphs
below I’ll refer to the above “coin” or combination as “full reserve banking”,
while still referring to the spurious distinction between narrow and limited
purpose used by Vickers.

Narrow banking.

Vickers’s objections to
narrow banking are in 3.20 and 3.21. The following (in green) is section 3.20
and the first half of 3.21.

3.20. Proponents of a
different kind of structural reform known as ‘narrow banking’ arguethat
the function of taking deposits and providing payments services to individualsand SMEs is so critical to the economy that
it should not be combined with riskyassets.
Under a strict form of narrow banking the only assets allowed to be held against
such deposits would be safe, liquid assets. Since lending to the private sector
necessarily involves risk, such banks would not be able to use the funding from
deposits to make loans to individuals and SMEs. Should ring-fenced banks be
allowed to make such loans?

3.21 If ring-fenced
banks were not able to perform their core economic function of intermediating
between deposits and loans, the economic costs would be very high. If all
current retail deposits were placed in narrow banks, around £1tn of deposits which
currently support credit provision in the economy would no longer be able to do
so. Alternative sources of credit could arise – for example if narrow banks
couldinvest only in short-term UK
sovereign debt (‘gilts’) the current investors in gilts wouldneed other assets to invest in, since the
stock of gilts would be more than taken up by the demand from narrow banks.

If you have any grasp of
how the banking system works you should be able to spot the flaw there. The
basic flaw is that Vickers regards money in a similar way to the way children
regard piggy bank money. That is, Vickers is assuming there issome sort of fixed pot of money to be
allocated to borrowers, or not, and that if money deposited in the ring-fenced
section of the banking industry cannot be loaned on, then relevant borrowers
will find it hard to obtain loans. The reality of course is that private banks
and central banks can and do expand and contract the money supply as they see
fit. And given the introduction of full reserve, they’d simply adjust the total
amount of money to suit, and as a result, thus there’d be none of the “high
economic costs” to which Vickers refers. But that glosses over a lot of detail,
so let’s look at the details.

The first mistake in the
above passage from Vickers is the assumption that depositors would want ALL
THEIR MONEY lodged in a 100% safe fashion. (That’s where Vickers says “If all
current retail deposits..” Notice the word “all”).

That is, some depositors
hold some of their money for the well-known “asset” motive, rather than for the
“transaction” motive, as explained in the introductory economics text books.

And “asset money” tends
to go into deposit or “term accounts” where it earns more than the zero rate of
interest normally available from current or checking accounts. And a proportion
of term account money, if full reserve banking were introduced, would be put
into investment accounts (under Positive Money’s full reserve system) or into
lending unit trusts under Lawrence Kotlikoff’s system. So to that extent (and
contrary to Vickers’s suggestions) there’d be no effect on the amount being
loaned to borrowers.

And even if the latter PM
or Kotlikoff accounts/entities were not specifically set up, they’d arise
automatically. That is, if the narrow banking rule were imposed, there’d be a
whapping great gap in the market which would be filled by entities offering
loans and funded by shareholders.

Let’s now turn to those
wanting money lodged in a 100% safe fashion.

Reduced lending.

Now suppose banks are
barred from lending out money in transaction / current / checking accounts. In
that case, as section 3.21 rightly points out, deposits would have to be backed
by what Vickers calls “safe liquid” assets. Section 3.21 suggests Gilts (i.e.
government debt). But monetary base would do equally well. Let’s say it’s the
latter.

That would mean the
central bank would have to make available an increased amount of monetary base
to meet the new demand. (I’ll deal with the possible inflationary effect of
that below).

But at the same time, as
Vickers rightly suggests, there would initially be significant number of viable
lending opportunities which would go unfunded. In Vickers’s phraseology there’d
be “economic costs”, which is a bit vague. To be exact, the above reduced
lending would have a deflationary effect .

But that’s easily dealt
with, and at no real cost simply by implementing stimulus (monetary and/or
fiscal). Problem solved! And some of that stimulus would cause additional
lending.

Given the constraints on
bank lending that are inherent to full reserve, it could well be there’d be
less lending even after the latter stimulus. Would that matter?

Well if you’re one of
those politicians who worship the ground that banksters walk on (that’s about
95% of politicians), and who think that the more lending and debt we have the
better, then less lending “matters”.

However the important
question here is: what’s the OPTIMUM amount of lending? Well I suggest the
optimum is the amount that takes place in a genuinely free market: that’s a
market where banks are not subsidised, as they are at the moment.

And under full reserve,
banks are not subsidised. Hence the optimum amount of lending and debt is the
amount that would take place under full reserve. QED. Game set and match to
full reserve banking.

“First, it would constrain banks’
ability to produce liquidity through the creation of liabilities (deposits)
with shorter maturities than their assets. The existence of such deposits
allows households and firms to settle payments easily.”

Well now everyone has tumbled to the
point that we need a form of money because that “allows households and firms to
settle payments easily”. But there is
absolutely no reason why the private sector has to do that job. That is, there
is nothing to prevent us having a system under which the only issuer of money
is the state. Indeed, many of those who have studied the origins of money claim
that in most societies or civilisations, money was first produced by the state
to facilitate collection of taxes. King Henry I’s introduction of tally sticks
to England around 1100AD was a classic example.

And full reserve is a system under
which only the state issues money. And under full reserve, the state would
issue whatever amount the private sector wanted: or to be more exact, whatever
amount induced the private sector to spend at a rate that brought full
employment.

Section 322 continues:

“Second, banks would no longer be
incentivised to monitor their borrowers, and it would be more difficult to
modify loan agreements. These activities help to maximise the economic value of
bank loans.”

Now where on Earth does Vickers get
the idea that “banks would no longer be incentivised to monitor their
borrowers”? Quite the reverse. That is, under the existing system banks can
make risky loans in the knowledge that if that pays off, they keep the profit,
but if it doesn’t, the taxpayer picks up the bill!!!

Not much of an “incentive to monitor”
there is there?

In contrast, under full reserve,
those who invest in entities that lend, stand to lose out if the entity makes
silly loans. That’s what I call “incentive” to monitor. In particular, and taking
the sort of full reserve system advocated by Positive Money and Lawrence
Kotlikoff and others, investors specifically have a choice as to what is done
with their money. So if they really want
to take a big risk, they can. But the probability is that about 95% of those
who currently have money in deposit or term accounts would want to see their
money used in a very conservative fashion. That is, they’d specify that their
money was used not to fund NINJA mortgages, but to fund for example mortgages
where house owners had a minimum 20% or so equity stake.

As for Vickers’s claim that under
full reserve “it would be more difficult to modify loan agreements..”, I’m
baffled. Under the law as it stands any two parties are free to come to any
agreement they like, as long as it’s not illegal: and in particular they can
include a bit of “modifiability” in the agreement, or not, just as they please.

Thursday, 27 February 2014

I’ve been rummaging thru the final report produced by the above,
and am less than impressed by section 3.23. In reference to providers of
deposit taking services, they say:

“So some risk of failure should be
tolerated but it must be possible for the authorities to ensure continuous
provision of vital services without taxpayer support for the creditors of a failed
provider.”

Now think about that. Ordinary
depositors are the main “creditors” of a “provider”. And Vickers is saying that
failure should be possible. Plus they’re saying that there should be no “taxpayer
support” in the event of failure.

Spotted the self-contradiction? If
not, it’s as follows.

What exactly is “failure”? It’s not
the fact of bank shares dropping to a quarter or even a tenth of their initial
value. That of itself does not make a bank or any other entity insolvent. There
is no reason for bank not to continue in business in the latter scenario.

So what Vickers is saying is that
banks shouldn’t be so safe that they’re never in the position of being unable
to pay depositors 100p in the pound, but that when failure does occur there
should be no “taxpayer support for the creditors of a failed provider.”

So Vickers in that sentence Vickers
is advocating the “Cyprus” solution for an insolvent bank: that’s telling
depositors to go hang. Now I bet you didn’t know Vickers advocated THAT.

And of course they don’t. In numerous
other passages, Vickers claims their ring-fence will reduce the LIKLIHOOD of
taxpayer funded bail outs, but they don’t claim such bailouts would be totally
impossible.

Tuesday, 25 February 2014

In Washington , DC, at a
Metro Station, in 2007, this man with a violin played six Bach pieces for about
45 minutes. During that time, approximately 2,000 people went through the
station. After about 3 minutes, a middle-aged man noticed that there was a
musician playing. He slowed his pace and stopped for a few seconds, and then he
hurried on to meet his schedule.

About 4 minutes later, the
violinist received his first dollar. A woman threw money in the hat and,
without stopping, continued to walk.

The musician played
continuously for 45 minutes during which time only 6 people stopped and
listened for a short while. About 20 gave money but continued to walk at their normal
pace.

After 1 hour he finished
playing and silence took over. No one noticed and no one applauded.

No one knew this, but the
violinist was Joshua Bell, one of the greatest musicians in the world. He
played one of the most intricate pieces ever written, with a violin worth $3.5
million dollars. Two days before, Joshua Bell sold-out a theater in Boston
where the seats averaged $100 each to sit and listen to him play the same
music.

This is a true story.
Joshua Bell, playing incognito in the D.C. Metro Station, was organized by the
Washington Post as part of a social experiment about perception, taste and
people's priorities.

This experiment raised
several questions:

*In a common-place
environment, at an inappropriate hour, do we perceive beauty?

*Do we recognize talent
in an unexpected context?

* If Bostonians or other
self-appointed connoisseurs of high culture were told that high culture
consisted of someone standing on their head, drinking beer and letting out the
occasional burp, would they pay $100 to watch? I suspect the answer is “yes”.

In relation to banks, Martin
Wolf
said “I accept that leverage of 33 to one, as now officially proposed is
frighteningly high. But I cannot see why the right answer should be no leverage
at all. An intermediary that can never fail is surely also far too safe.”

I gave some answers to
that question here.
And here is another answer….

The higher are capital
ratios, the easier it is for private banks to lend money into existence. E.g.
if the ratio is 5%, banks only need one pound of extra capital for every
nineteen pounds of extra lending. Now what do private banks do with that
freedom? That is, are the main gyrations in their money creation activities
explained by sudden upsurges in the number of worthwhile and viable industrial
investments?

Well as should be obvious
to everyone apart from new-born babies and the inmates of mental homes, “worthwhile
industrial investments” has nothing to do with the gyrations in bank lending.
The gyrations are explained almost exclusively by outbursts of irrational
exuberance: e.g. house price bubbles. For example in the three years or so
prior to the recent crises, bank lending (red in the chart below) in the UK was expanding far faster than
the expansion of base money (blue).

And of course the state
(in the form of the central bank and/or treasury) have to counteract those
gyrations.

So why not just ban
private money creation altogether, first, because the state already creates a
form of money, i.e. base money, and second, if private banks are allowed to
create money, that simply leads to instabilities which the state has to
counteract?

Non-peer reviewed (or only lightly peer reviewed) publications. The coloured clickable links below are EITHER the title of the work, OR a very short summary (where I think a short summary conveys more than the title).

i) The above is not a complete list in that earlier versions of some papers have been omitted. For a more complete list see here, and “browse by author” (top of left hand column).

ii) 7 deals with a wide range of alleged reasons for government borrowing, including Keynsian borrow and spend. 6 is an updated version of the "anti-Keynes" arguments in 7. 5 is an updated version of 1, which in turn is an updated version of 4.

______________

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Bits and bobs.

.

As I’ve explained for some time on this blog, the recently popular idea that “banks don’t intermediate: they create money” is over-simple. Reason is that they do a bit of both. So it’s nice to see an article that seems to agree with me. (h/t Stephanie Schulte). Mind - I've only skimmed thru the intro to that article.________

Half of landlords in one part of London do not declare rental income to the tax authorities. I might as well join in the fun. I’ll return my tax return to the authorities with a brief letter saying, “Dear Sirs, Thank you for your invitation to take part in your income tax scheme. Unfortunately I am very busy and do not have time. Yours, etc.”________

Simon Wren-Lewis (Oxford economics prof) describes having George Osborne in charge of the economy as being “similar to someone who has never learnt to drive, taking a car onto the highway and causing mayhem”. I’ll drink to that.

Unfortunately SW-L keeps very quiet, as he always does, about the contribution his own profession made to this mess. In particular he doesn’t mention Kenneth Rogoff, Carmen Reinhart or Alberto Alesina – all of them influential economists who over the last ten years have advocated limiting stimulus (because of “the debt”) if not full blown austerity.________

Plenty of support in the comments at this MMT site for the basic ideas behind full reserve banking, though the phrase “full reserve” is not actually used.________

Old Guardian article by Will Hutton claiming the UK should have joined the Euro. Classic Guardian and absolutely hilarious.________

One of the first “daler” coins (hence the word “dollar”) weighed 14kg.!!! Imagine going shopping for the groceries with some of those in your pocket, or should I say “in your wheelbarrow”. (h/t J.P.Koning)________

Moronic Fed official reveals that GDP tends to rise when population rises. Next up: Fed reveals that grass is green and water is wet….:-)________

Fran Boait of Positive Money says the Bank of England "has no capacity to respond to a future crisis, and that puts us in an extremely dangerous position." Well certainly there are plenty of twits at the Treasury and at the BoE who THINK responding will be difficult. Actually there's an easy solution: fiscal stimulus, funded (as suggested by Keynes) by new money. Indeed, that’s what PM itself advocates. But it’s far from clear how many people in high places have heard of Keynes or, where they have heard of him, know what his solution for unemployment was.________

The US debt ceiling has been suspended or lifted 84 times since it was first established. You’d think that having made the Earth shattering discovery 84 times that the debt ceiling is nonsense, that debt ceiling enthusiasts would have learned their lesson, wouldn’t you? I mean if I got drunk 24 times and had 24 car crashes soon afterwards, I’d probably get the point that alcohol causes car crashes…:-) As for getting drunk 84 times and having 84 car crashes, that would indicate extreme stupidity on my part. No?________

The US Treasury has the power to print money (rather in the same way as the UK Treasury printed money in the form of so called “Bradburies” at the outbreak of the first World War).________

“Payment Protection Insurance” was a trick used by UK banks: it involved surreptitiously getting customers to take out insurance against the possibility of not being able to make credit card or mortgage payments. UK banks have been forced to repay customers billions. But that’s just one example of a more general trick used by banks sometimes called “tying”: forcing, tricking or persuading customers to buy one bank product when they buy another. More details here on the Fed’s half-baked attempts to control tying in the US.________

The farcical story of economists’ apparent inability to raise inflation continues. As I’ve long pointed out, Robert Mugabe knows how to do that. In fact Mugabe should be in charge of economics at Harvard: he’d be a big improvement on Kenneth Rogoff, Carmen Reinhart and other ignoramuses at Harvard.________

I’ve removed comment moderation from this blog. The only reason I ever implemented it was so as get rid of commercial organisations advertising something and posing as commenters. When doing that I noticed comments were limited to people with Google accounts for some strange reason. Removed that as well. ________

Article on money creation by Prof Charles Adams, who as far as I can see is a professor of physics at my local university – Durham. I can’t fault the first half of his article, but don’t agree with the second half which claims both publically and privately issued money are needed because we have a public and private sector. I left a comment.

Adams is nowhere near the first physicist to take an interest in money creation. Another is William Hummel. These “physicist / economists” are normally very clued up (as befits someone with enough brain to be a physicist).________

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MUSGRAVE'S LAW SOLVES THE FOLLOWING PROBLEM.

The problem. Deficits and / or national debts allegedly need reducing. The conventional wisdom is that they are reduced by raising taxes and / or cutting government spending, which in turn produces the money with which to repay the debt. But raised taxes or spending cuts destroy jobs: exactly what we don’t want. A quandary.

The solution. The national debt can be reduced at any speed and without austerity as follows. Buy the debt back, obtaining the necessary funds from two sources: A, printing money, and B, increasing tax and/or reduced government spending. A is inflationary and B is deflationary. A and B can be altered to give almost any outcome desired. For example for a faster rate of buy back, apply more of A and B. Or for more deflation while buying back, apply more of B relative to A